Methanex Corp. is a Market Leader with Potential to Unlock Value

The current stock price for Methanex Corporation (MEOH) provides a solid entry point for investors. Declining methanol prices, and a plant shutdown in Eygpt created a stock pullback from recent highs.  These problems are temporary and even in a bear case the company offers normalized 2015 FCF yields of ~9%. MEOH has the potential to unlock further value if methanol prices increase, if U.S. assets are converted to an MLP structure, if a natural gas feedstock contracts can be obtained in Chile, or if positive NPV projects are undertaken. I would wait until after the Q2 earnings release to buy-in as a negative surprise is more likely than a positive surprise.

To read full write-up click here: MEOH Write-up

Energous Corporation – Cool Technology, but Potential Market is Too Small

Energous Corporation (WATT) attracts speculative investors who are interested in the company’s upside potential. I do not believe it will materialize. Bulls do not understand the difficulties that WATT will face related to competition, regulatory approval, getting to market on time, and monetization of its technology. As WATT does not yet have any revenue, stock price movements will be driven by events related to the companies deteriorating future business prospects. There are numerous points in the future when investors could be let down. I expect mass selling when lockout periods end in September 2014 and March 2015.

To read the full write-up click here: WATT Write-up

Follow Insider Buying To Find Solid Investments

A good investing strategy that has been back-tested and proven effective over time is following the inside money. This strategy is based on the fact that company insiders, CEO/CFO/Directors, know more about their companies than the public does. The SEC requires that insiders disclose, within two days, when they buy or sell their own stock. Investors could potentially outperform the market by buying when insiders are buying and selling when they sell. Back-testing has shown that this strategy works.

Professors at Harvard, Chicago, and Michigan have tested and confirmed the strategy’s effectiveness. I first learned of the strategy from an MBA professor that I had at the University of Michigan. He found that between 1975 and 1994, investing in companies with insider buying produced an alpha of 3.7%.

When you begin to factor in other factors like who is doing the buying and the size of the purchase they made you can improve results even further. Between 2003 – 2010 when top insiders bought more than 10,000 shares of their own stock, it was followed by returns of ~25%. This is a timely strategy because Dodd Frank changed the timing of insider disclosures. Instead of waiting 30 days or more now company insiders must disclose transactions within 2 days.

If you are new to the stock market or simply do not have time to research stocks then this is certainly a great strategy to follow. Simple screeners such as http://www.finviz.com can tell you who which companies and experiencing significant insider transactions. If you are an experienced investor than this would be a great place to look for ideas.

To read more click here: Insider Buying White Paper

CONN: Growing Only by Loosening Credit Standards

Conn’s (CONN): A retailer and subprime lender with 79 retail stores selling mattresses, appliances and electronics. It operates in low-income areas where it offers financing for overpriced products at high rates. This short is crowded but is still a good idea. Market Cap $1.5B.

Short thesis:

1. Its recent growth has all come from extending more credit and loosening credit standards.
2. When valuing the subprime credit and retail businesses separately as opposed to viewing CONN as a growth retailer, a sub $30 value is more appropriate.
3. It is unclear how well CONN will mange the increased credit risk. Large losses could occur in the accounts receivable (AR) portfolio.

1. The AR portfolio was $1.07B on Jan. 31, 2014, up 44.1% from the prior year. Average account balances are up over 28% in the last two years, while credit scores and down payments have dropped. CONN has posted positive net income for two straight years after two years of losses, but at the same time cash flow from operations (CFO) has been negative in the last two years. This growth is unsustainable as CONN had CFO losses of ($210M) last year and has only $295M of available debt under its credit facility and minimal cash.

2. The company should be viewed as a retailer and subprime lender by the market. When applying separate valuations for these two businesses, a price below $30 would make more sense. Income before taxes from the credit segment slipped from $28.5M to $12.5M in the most recent year. With bad debt increasing in the most recent quarter, the credit segment had a ($6.5M) loss. The decline in quality of the credit segment and lower multiple associated with subprime lending should bring the valuation down.

3. Bad debt expense will certainly go up, but it is unclear how much this problem will be compounded by repeat customers and growing debt burdens per customer. ~60% of payments are made at store locations, which could pose additional credit problems when closing stores.

Next Steps: I plan to research the AR portfolio and lending standards. There is an advantage to be gained by understanding the quality of the AR portfolio better than Wall Street.

Potential Catalysts: Missing guidance as bad debt piles up and growth slows. As problem loans are given time to surface, the street will have more reason to value the two businesses separately, creating multiple compression.

 

LifeLock: A Low Value Add Service Company Facing Headwinds

LifeLock (LOCK): An identity theft protection company, using a subscriber model that is marketed directly to consumers. Market cap $1.2B.

Short Thesis:

1. This company could potentially be exposed for lacking a value-added service, fraud, or false advertising…again.
2. It is competing in a bad space; the industry has slow growth, is competitive, and is becoming saturated.
3. It is promoted and valued as a growth tech stock, but it is clearly in the services space.

1. Industry experts have been quoted saying that LOCK’s basic level service package is useless. It offers no services that a consumer could not easily do himself. Examples are that consumers could monitor their own credit or add themselves to do-not-disturb lists. Most subscribers use the basic package. Even more expensive services are also of little benefit. For example, wallet protection where the company will call your credit cards for you when your wallet has been stolen. The company was fined by the FTC in 2010 for deceptive advertising, which could happen again. Since its services do not offer much to consumers the company must resort to questionable advertising to convince customers of the need for its services. LOCK does not even protect consumers from wage or tax fraud, which are the FTC’s two most common types of identity theft. However, people may continue to pay for the services unless a regulatory body steps in.

Robert Maynard, cofounder, left the company in large part due to his checkered past of bad business practices, fraud, and arrests. Anyone who would collaborate with this person in my mind is suspect. I think the company is at high risk of accounting fraud and bad business practices. I also believe that the ~$400 estimated value per customer is alarming. I would like to research how competitors calculate customer EV. I would also like to dig further for any aggressive accounting practices.

2. A negative earnings surprise could occur because growth in the industry is slow and the cost to acquire new customers is becoming more expensive as the market becomes saturated. The identity protection space is $3.5-4B and growing slowly. IBIS World predicts 4.2% growth this year. Competition is fragmented and fierce; there are 79 players in this space. Large banks service 50% of the current demand. LOCK has been aggressively building market share by increasing advertising spending. The cost to acquire a new customer is up to $160; this is in contrast to $150 at the end of 2012. This is a major expense since the average subscriber pays only $10.81 a month.

Identity protection is a commoditized product. Competitors use the same data and services for information, making it harder for LOCK to stand out.

The B2B revenue (~6% Revenue) is shrinking because of increased regulation. COF settled a $215M suit related to deceptively providing identity/fraud protection for similar services.

3. LOCK is touted by management as a growth tech company, but it is clearly in the services space. Its valuation is way out of line with INTX, the only true pure-play competitor. This is due partly to the fact that INTX competes in the shrinking B2B space, but INTX could easily replicate LOCK’s business model.

Next steps: I plan to dig deeper into competitors’ plans, expected value per customer calculations, and regulatory developments.

Potential catalysts: Missing top and bottom line guidance, a multiple correction from the street after pricing LOCK as a services company, and FTC/legal sanctions.

Noodles & Company Is Not Taking Off As Planned

Noodles & Company (NDLS) will have trouble meeting 2014 guidance, and does not deserve its high growth expectations. Same store sales were (1.6%) in 14Q1 and management has kept their full year comp guidance at 2.5-3%. It will take a big 2H of 2014. At the same time the company faces the risk and cost of moving into new territories. NDLS has low returns on capital compared to peers but has recently been touted as the next Chipotle. Investors are catching on but stock price can still go lower, I target a price of $28 after a couple more disappointing quarters.

To read the full quick idea click here: NDLS Quick Idea

Hibbett Sports Missing The Boat On E-commerce

Hibbett Sports (HIBB) is facing increased competition from big box stores and e-commerce while its margins compress due to expansion expenses. DKS and Academy are moving into HIBB markets and the company remains the only major sports retailer without an online presence. HIBB trades at a premium to peers based on future growth and share buybacks neither of which are a certainty.

To read the full quick idea click here: HIBB Quick Idea

VCA Antech Is Losing Share To Competition

VCA Antech (WOOF) is treading water in a market that is growing and faces the risk of impairment to its $1.3B goodwill asset. I predict slower top-line growth and operating margin/multiple compression in 2014 as volumes continue to fall. Stock price has been outpacing the general market multiple expansion by 31% bolstered by a change in accounting policy, and an announced share repurchase plan in 2013. Amortization expenses no longer hit the income statement. 1-year price target of $25.40 as earnings underperform estimates and multiple shrinks.

To read full quick idea click here: WOOF Quick Idea

Foundation Medicine Inc. Is Not The Growth Story Investors Expect

Foundation Medicine Inc. (FMI) trades at a premium to other diagnostic companies due to irrational exuberance in the IPO market. It faces the obstacles of third party insurer/Medicare approval, oncologist acceptance, and the recent emerging of a substitute service at a lower cost. The company had an IPO in September 2013 at a share price of $18, which jumped 78% in the first day. The stock has the characteristics of a trendy IPO including the backing of Google Ventures and other cachet funds, plus offering a first of its kind diagnostic test. Investors are expecting to see fast growth. Current valuations do not make sense as FMI has not yet had profits and will face headwinds growing. I expect a price of $20 in 1 year as the company fails to achieve the growth baked into price.

To read the full quick idea click here: FMI Quick Idea

Lessons Learned From Michael Burry

For those of you who have never heard the name, Michael Burry was the hedge fund manager of Scion Capital and one of the main characters of the book, The Big Short, by Michael Lewis. Michael Lewis is my favorite author and Michael Burry is an interesting character and great investor. Burry became famous in the investing world when blogging about his ideas, during his residency. No one knew where he found time to research investments and learn medicine. He is a deep value investor and often takes a contrarian approach, going opposite of the market. His favorite stocks are those near 52-week lows. Burry is a genius, who used his intense focus to dig up great investments. It was found in the last several years that his focus came partially from having autism. He knew that the housing market in the U.S. was due for a correction and he made a fortune off of the credit crisis. He made huge bets against mortgage-backed securities. This is what got him a spot in Lewis’s book. Having worked at Freddie Mac, I took a particular interest in his story. I had a front row seat for the credit crisis. And no, I did not become rich while working at Freddie Mac, I left because I lost faith in management. I have a strong distaste for those who relaxed their morals in order to make money and I do not think that anyone should be able to place a bet against the mortgage market. It is Un-American. I do like that Burry was known for speaking his mind. He would tell important people off right to their face if he thought they were telling lies about the mortgage market. Burry is a smart guy and there is a lot that we can all learn from him. I recently read a compiled version of his 2000/2001 blogs and I wanted to write about some of my takeaways. To read all of Michael Burry’s case studies click here: Michael-Burry-Case-Studies.

I do not agree with everything that Burry believes, but three things hit home for me when reading his blog. The first was that the maximum margin of safety is found when irrational selling is at its peak. Burry exclaims that ideally, illiquidity and disgust will pair up in tandem with pugilism when stocks go out of favor. It also shocked me the level of premonition he had. He predicted the housing crisis and also accounting changes related to amortizing of goodwill, and handling of off-balance sheet items. He made money by rightfully suspecting that many companies amortized goodwill to conceal problems. He had great insight when it came to risks, and he got it by looking at all investments skeptically. He did not trust management and that tailored his approach. I try to be a skeptic when first looking at a stock. I often look for a reason not to buy. The last takeaway was don’t worry about missing a rally, worry about losing your money. Burry would sell a stock if it went 10-15% below a previous low. He was a commodity trader at one point and the technical analysis concept of support carried with him. Burry didn’t worry about indexes he worried about stocks. He was never trying to play catch up and he knew not to take additional risks to get his money back after a loss.

I liked learning more about him but my style of investing is still different from Burry’s style. I look in other places for investment ideas besides stocks at 52-week lows. I also do not short on valuation. Burry’s thesis behind shorting Magna Design Automation was that it was overvalued. I tend to think that things can stay irrationally overvalued for a long time. All in all this is a good read and I think that any investor could learn a thing or two from Michael Burry.